Foreign Exchange Margin Trading: Earn Higher Profits With Less Borrowing Your Broker's Money

Forex margin trading is a way of using leverage to increase the purchasing power of your money. Leverage basically means using a small amount to control a much larger amount. This is possible because it is improbable that the price of a currency will change by more than some percentage points over a short time. So you can place a few hundred dollars in your brokerage account to trade on the margin - the amount that you think the rate could change. Your broker will in effect permit to borrow you the balance.

Trading on margins is also known in stock and commodities trading, but because of the special nature of currencies, you can get a much higher leverage in the currency markets. Depending on your broker's terms, you may be able to control 50, 100 or even 200 times your account balance.

This can produce big profits if you are successful, but it can also result in big losses if not. All things considered, the more leverage you use, the more risky your trading is.

We can understand leverage and margins if we consider an example.

Imagine that the current rate on the British pound to US dollar currency market is shown as GBP/USD 1.7100. So to buy one British pound you would need $1.71. If you hoped for the value of the dollar to soar against the pound you could decide to sell enough pounds to buy $100,000. If your broker used lots of $10,000 each, this would be 10 lots. Then you would sit back and wait for the price to go up.

Some days later you might find that the price had moved to GBP/USD 1.6600. Sure enough, the dollar has risen and the pound is now worth only $1.66. If you sell your dollars now and buy back into pounds, you will have made a profit of 2.9% less the spread. 2.9% of $100,000 is $2,900, so that would be a fantastic trade.

But most of us do not have $100,000 spare cash that we want to trade on the forex markets. So here is where the essence of margin trading comes into play.

Since you are buying and selling different currencies at the same time, your own cash only has to cover any loss that you would certainly make if the dollar falls instead of rising. And you would put a stop loss to limit that loss, so $1,000 might be all you needed to have in your account to make this $100,000 transaction. Your broker guarantees the other $99,000.

Actually most brokers now operate limited risk amounts where the account will automatically close out the trade if whatever funds you have in your account are lost. This prevents margin calls which can be disastrous for a trader because they mean that you can lose more than you have. But with a forex limited risk account that is impossible. The broker's software that you use to control your account will not let you lose more than your account balance.

Using leverage in this way is so common in forex trading that you will soon do it without even thinking about it. Still it is important to bear in mind the risks. Lower leverage is always safer and you may never want to go to the highest edge forex margin that your broker would allow. You can also reduce your risk by using highly reliable forex signals. There are many forex signal providers available online. But keep in mind the fact, that not all forex signals are winners, so don't risk too much on any single trade.

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